Free Cash Flow Valuation

Question 1

What is free cash flow?

Answer 1

• cash flows available for distribution

Question 2

When is FCFF or FCFE discount model preferred?

Answer 2

• company does not pay dividends
• dividends are not reflective of the dividend capacity
• forecasted free cash flows align with profitability
• investor takes a control perspective

Question 3

What is the difference between FCFF & FCFE?

Answer 3

• FCFF: cash flow available to all capital providers after payments for operating expense, working capital investments, and fixed capital (CFO - capital expenditures)
• FCFE: FCFF minus payments to debt holders (cash flow available to equity providers)

Question 4

What is formula for equity value and for firm value using present value of FCFF?

Answer 4

firm value = FCFFt / (1+WACC)^t

FCFF = free cash flow to firm
WACC = weighted average cost of capital

equity value = firm value - market value of debt

Question 5

What is formula for WACC using present value of FCFF?

Answer 5

WACC = ([MV of Debt/ MV of Debt + MV of Equity] * (rd * (1-tax rate)))+ ([MV of Equity / MV of Debt + MV of Equity] *re)

rd = cost of debt or rate of debt
re = cost of equity or rate of equity

Question 6

What is formula for equity value using present value of FCFE?

Answer 6

equity value = FCFEt / (1+r)^t

FCFE = free cash flow to equity
r = discount rate or required rate of return
t = time

Question 7

What is formula for firm value and FCFF using single stage constant growth FCFF valuation model?

Answer 7

FCFF1 = FCFF0 * (1+g)

FCFF1 = free cash flow to firm in 1 year
FCFF0 = free cash flow to firm now
g = constant growth rate

Firm value = FCFF1 / (WACC-g)

WACC = weighted average cost of capital

Question 8

What is formula for equity value and FCFE using single stage constant growth FCFE valuation model?

Answer 8

FCFE1 = FCFF0 * (1+g)

FCFE1 = free cash flow to equity in 1 year
FCFF0 = free cash flow to equity now
g = constant growth rate

equity value = FCFE1 / r-g

Question 9

What is formula for FCFF from net income?

Answer 9

FCFF = NI + NCC + (INT*(1-tax rate)) - FCinv -WCinv

NI = net income
NCC = non cash charges
Int = interest expense
FCinv = investment in fixed capital
WCinv = investment in working capital

Question 10

What is formula for FCFF from statement of cash flows? What is the formula for statement of cash flows used in calculation of FCFF?

Answer 10

FCFF = CFO + (Int * (1-tax rate)) - FCinv

CFO = cash flow from operating activities
Int = interest expense
FCInv = investment in fixed capital

CFO = NI + NCC - WCInv

NI = net income
NCC = non cash charges
WCinv = investment in working capital

Question 11

What are 6 non cash items that need to be added back to NI when calculating FCFF?

Answer 11

• depreciation/amortization
• impairment of intangibles
• restructuring charges
• losses
• amortization of long term bond discounts
• deferred taxes

Question 12

What are 3 non cash items that need to be subtracted from NI when calculating FCFF?

Answer 12

• expense reversals
• gains
• amortization of long term bond premiums

Question 13

What is the formula to calculate FCFE from FCFF?

Answer 13

FCFE = FCFF - (Int * (1-tax rate)) + net borrowing

FCFF = free cash flow to firm
net borrowing = long term debt

Question 14

What is the formula to calculate FCFE from NI and CFO?

Answer 14

FCFE = NI + NCC - FCinv - WCinv + net borrowing

NI = net income
NCC = non cash charges
FCinv = investment in fixed capital
WCinv = investment in working capital
Net borrowing = different in long term debt

FCFE = CFO - FCinv + net borrowing

CFO = cash flow from operations

Question 15

How should firms with a bunch of non operating assets be valued and what are examples of non-operating assets?

Answer 15

• firms with significant non-operating assets should be valued as the total value of all of their assets, not just their operating assets (important for calculating CFO, which is cash flow from operations)

examples:
- Excess” cash and marketable securities
- Non-current investments in stocks and bonds
- Land held for investment
- Pension surplus

Question 16

What is formula for firm value using 2 stage free cash flow models?

Answer 16

firm value = (FCFFt / ((1+WACC)^t)) + {(FCFFn +1 / WACC-g) * (1/(1+WACC)^n)}

Question 17

What is the formula for calculating FCFF from EBIT and what is the formula for EBIT?

Answer 17

FCFF = (EBIT * (1-t))+ DEP - FCinv - WCinv

EBIT = earnings before tax
T = marginal tax rate
DEP = depreciation
FCinv = investment in fixed capital
WCinv = investment in working capital

EBIT = NI + (interest * (1-t)) / 1-t

Question 18

What is the formula for calculating FCFF from EBITDA?

Answer 18

FCFF = (EBITDA * (1-t)) + dep(t) -FCinv -WCinv

EBITDA = earnings before interest, taxes, decoration, & amortization
t = tax rate
Dep = depreciation
FCinv = investment in fixed capital
WCinv = investment in working capital

Question 19

What are the 3 basic uses of FCFF?

Answer 19

• retain funds (increase cash balance)
• pay providers of debt capital (interest & principal payments
• pay providers of equity capital (dividends & share repurchases)

Question 20

What is the formula for calculating FCFF from its uses?

Answer 20

FCFF = increase in cash balance + (interest expense * (1- tax rate)) + debt repayment + cash dividends + share repurchase

Question 21

What is the formula for calculating FCFE from its uses?

Answer 21

FCFE = increase in cash balance + cash dividends + share repurchase

Question 22

What is the formula for a sales based forecast on FCFF?

Answer 22

FCFF = (EBIT*(1-tax rate)) - (FCInv - Dep) - WCinv

FCinv - Dep = incremental fixed capital expenditure net of depreciation
WCinv = incremental working capital expenditures

Question 23

What is the 3 step process for estimating (FCinv-Dep) and WCinv when performing a sales based forecast for FCFF?

Answer 23

1. Forecast constant growth rate for sales
2. multiple (FCinv-dep) and WCinv with the constant growth rate for sales to find the new incremental increase for (FCinv-dep) and WCinv (use the following formulas)

FCinv-dep increase = capital expenditures - depreciation expense /increase in sales
WCinv = increase in working capital / increase in sales

3. plug in new figures into formula for FCFF using sales based forecast

Question 24

What is formula for FCFE is we assume that a company will adjust its capital structure to a target debt ratio?

Answer 24

FCFE = NI - ((1-DR)(FCinv-Dep)) - ((1-DR)WCinv)

NI = net income
DR = target debt ratio
FCinv = investment in fixed capital
WCinv = investment in working capital

Question 25

What is formula for FCFF is company has preferred stock?

Answer 25

FCFF = NI + NCC + (Int* (1-tax rate)) + preferred dividends - FCinv - WCinv

NI = net income
NCC = non cash charges
FCinv = investment in fixed capital
WCinv = investment in working capital

Question 26

What is formula for required rate of return for an international application of single stage model?

Answer 26

r = country return +industry adjustment +size adjustment +leverage adjustment

r = real required rate of return

Question 27

What is the formula for valuing a company using real rates?

Answer 27

V0 =FCFE0 *(1+greal) / (rreal - greal)

g real = growth rate of real return
r real = required rate of real return

Question 28

What is formula of for value of firm using sensitivity analysis?

Answer 28

V0 = FCFE0 * (1+g) / [risk free rate + B(equity risk premium)] - g

B = beta
Equity risk premium = return of market - risk free rate